Crispin Odey: "You need three bear markets before you know what to do"

Investment managers who haven’t lived through at least two bear markets are bound to make serious blunders, a bit like jockeys who haven’t yet fallen off a horse. The fact they have never experienced the joys of ending up face down in the mud, as their horse advances riderless and aimlessly, means they probably don’t know the meaning of risk and have a tendency to lose their backers' money.

In a recent interview with Management Today, the City of London-based hedge fund manager Crispin Odey, indicated that fund managers only earn their spurs once they have been through at least three stockmarket reversals. Odey told Management Today that:

“You need three bear markets to know what to do. The first nearly wipes you out, the second you learn how to survive and the third you take by the scruff of the neck and enjoy it."

Odey founded Odey Asset Management in 1991. Today the firm, which operates from two wood-panelled town houses in Mayfair, employs 70 people and has £6.5bn-£7bn under management. Odey awarded himself a £28m performance bonus in 2008 after successfully shorting UK bank stocks.

In the interview with MT's Chris Blackhurst, the latter wrote that Odey “came a cropper spectacularly [in 1994] when one of his funds lost 44% of its value." He cited Odey as saying:

"You lose the respect of the market at that point [I thought rates would fall because of deflation] but Alan Greenspan, the then US Federal Reserve chairman, raised interest rates and I found out what it was like to be on the wrong side."

Odey had taken a massive long position on US bonds saying that:

"When I bought them we weren't afraid of interest rate movements, up or down, it wasn't what we were expecting. We'd had a fantastic run but that hadn't taught me much in the way of risk controls."

Odey was left overweight in an asset class that had become a licence to lose money, which he described as a "horrible moment". Blackhurst said his reputation was in tatters and "95% of his clients withdrew their money". In the half decade from 1994 to 1999,"only one new client came in. It was a solitary life", Odey told Blackhurst.

The Management Today article is a superb illustration of the advantages of "getting one's crisis in early," suggesting that investors who have had their fingers burnt early in their careers are much less likely to make basic errors in subsequent crises - and perhaps even to ride them out with aplomb.

This reminded me of an interview I recently did with the retired non-executive director of a UK bank (one of the ones that had to be rescued by the UK government in October 2008).

He argued that aspects of the UK’s Combined Code of corporate governance, which is policed by the likes of Pensions & Investment Research Consultants, Manifest and activist investment manager Hermes Pensions Management had played a big part in the bank's collapse.

He argued that the code's insistence that non-executive directors should quit after nine years (or else lose the "independent" assignation) caused the bank no end of trouble, since it meant that by 2007 it was peopled entirely by those without any experience or knowledge of charting the bank through earlier crises.

It meant nobody who sat on the bank’s board in the the 1988-91 crisis (when salutary lessons were learnt) remained in post after 2005, and that as a result nobody was inclined to rein in the bank's hubristic and egotistical chief executive or stopped him from taking outrageous risks as the credit bubble inflated in 2006 and 2007.

I believe the former director has a point. In banking, as in asset management, experience counts for much. Perhaps we'd all be better off if (bank?) boards were forced to retain at least one non-executive director with direct experience of previous life-threatening crises. Anyone who has been scarred by encounters with bears, as Odey was, is going to be more attuned to the dangers of running with the bulls.

Further reading on the value of experience in asset management and banking: